Startup Investor Workshop (Intermediate Session) | Brightspark Ventures and OurCrowd
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Slides and notes from the MaRS Startup Investor Workshop. The event took place on September 30th, 2016 and featured Mark Skapinker and Sophie Forest from Brightspark, David Shore from OurCrowd.
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Startup Investor Workshop (Intermediate Session) | Brightspark Ventures and OurCrowd
- 3. LEGAL DISCLAIMER The information contained in this presentation is provided solely for informational purposes and does not constitute an offer or solicitation of investment in any Brightspark or OurCrowd limited partnership related to any companies. Anything contained in this presentation should not be construed as creating a presumption by you, Brightspark or OurCrowd that you are an accredited investor. We make no representation or warranty, express or implied, with respect to any data provided to you regarding any information provided by the companies on its web site or in this presentation, and will not be liable in any way to you or to any other person for any inaccuracy, error or omission of any company data. Please be aware that investments in early stage companies contains a high level of risk and you should consider this prior to making any investment decisions. Learn more: www.brightspark.com/risk www.ourcrowd.com/disclaimer
- 4. INDIVIDUALS ARE INVESTING IN CANADIAN STARTUPS The weather is cold, but the market is hot!
- 5. INVESTING SERIOUSLY IN STARTUPS Build your network and reputation – let the deals come to you Build deal flow Determine your investment strategy Thesis, Pace, Focus Learn from other people’s mistakes Educate yourself
- 6. WHAT’S IN A TERM SHEET? Money + Control Non-legally binding Confidential Drafted by the lead investor New term sheet every round of financing, but the first term sheet sets the grounds for future funding
- 7. CONQUERING THE TERM SHEET Price / Valuation Two things impact valuation: stock option pools and warrants Entrepreneur math VS investor math $______ per share (the Original Purchase Price). The Original Purchase Price represents a fully-diluted pre-money valuation of $ __ million and a fully-diluted post money valuation of $__ million. For purposes of the above calculation and any other reference to fully-diluted in this term sheet, fully-diluted assumes the conversion of all outstanding preferred stock of the Company, the exercise of all authorized and currently existing stock options and warrants of the Company, and the increase of the Company’s existing option pool by [ ] shares prior to this financing.
- 8. VALUATION How do you determine a fair valuation? Market comparables Previous rounds Traction Team Competition for the deal Ownership amounts / percentages to motivate founders and management Analysis of what a “win” gets you upon an exit
- 9. CONQUERING THE TERM SHEET Liquidation preference – two scenarios Important terms: • Liquidity event • Actual preference • Participation: full participation, capped participation, non-participation WIN LOSE If the company sells for X times investment If the company sells as a “fire sale”, investors want to ensure you get your money back before the people who have “sweat equity” or founder shares.
- 10. CONQUERING THE TERM SHEET Liquidation preference example: Priority for a cumulative dividend of X% per annum, compounded annually (the “Preferred Return”), payable only in case of a liquidation event pursuant to which the Preferred Shares are not being converted. Upon occurrence of a liquidation event, holders of Preferred Shares shall be entitled to the greater of: the as-converted to Common Share amount; and Receive payment in preference to any other junior securities, from the assets of the company available for distribution, of an amount equal to original issue price of such Preferred Share plus the Preferred Return plus all declared but unpaid dividends.
- 11. CONQUERING THE TERM SHEET Operating the company You want to ensure that the company will be well managed, that there are appropriate “checks and balances” in place, that shareholders rights are protected. Board of Directors • Usually a balance of investor, company, founder and outsider representation • Chosen by mutual consent of the board OR voted upon on the basis on proportional share ownership on a common-as-converted basis Ask yourself Do you want board representation, control, observer rights?
- 12. CONQUERING THE TERM SHEET Protective Provisions Rights that investors have on certain actions by the company. They do not eliminate the ability to do certain things, they simply require consent of the investor. What entrepreneurs want VS what investors want Often negotiated: • Raising of the debt threshold • Minimum threshold of pref shares outstanding for the protective provisions to apply
- 13. CONQUERING THE TERM SHEET Anti-Dilution Used to protect investors in the event a company issues equity at a lower valuation then in previous financing rounds. Important terms: • Weighted average anti-dilution • Ratchet-based anti-dilution Anti-dilution math: NCP = OCP * ((CSO + CSP) / (CSO + CSAP))
- 14. CONQUERING THE TERM SHEET Pay-to-play In a pay-to-play provision, an investor must keep “paying” (participating pro ratably in future financings) in order to keep “playing”(not have his preferred stock converted to common stock) in the company. Much less common than 10 years ago.
- 15. CONQUERING THE TERM SHEET Drag-Along Agreement Tag along (or “co-sales”) The [holders of the Common Stock] or [Founders] and Series A Preferred shall enter into a drag-along agreement whereby if a majority of the holders of Series A Preferred agree to a sale or liquidation of the Company, the holders of the remaining Series A Preferred and Common Stock shall consent to and raise no objections to such sale.” All Parties grant each other the right (as for the Founders; after the expiration of any lock-up period, see above) to participate in any sale of the Company’s share capital in the same proportion and on the same terms and conditions as offered to the selling Party.
- 16. INVESTOR RIGHTS Redemption rights Redemption rights are principally designed to protect investors from a situation where, after a period of time, their portfolio company is just moving “sideways” and, accordingly, is not an attractive acquisition target or IPO candidate. In that case, the company could be required to repurchase their shares back. Unless prohibited by law governing distributions to stockholders, the Series A Preferred shall be redeemable at the option of holders of at least [__ ]% of the Series A Preferred commencing any time after the [fifth] anniversary of the Closing, at a price equal to the Original Purchase Price [plus all accrued but unpaid dividends]. Redemption shall occur in [three] equal annual portions. Upon a redemption request from the holders of the required percentage of the Series A Preferred, all Series A Preferred shares shall be redeemed [(except for any Series A holders who affirmatively opt-out)].”
- 17. INVESTOR RIGHTS Pro-Rata Participation Right The right to continue to participate in future rounds so that you can maintain your ownership. VERY important to investors. Why? Because you want to “double down on your winners”. So, you want the company to be OBLIGED to let you invest more if you want to in future financings.
- 18. Diligence Defines: • Satisfaction of the Lead Investor with the results of its due diligence investigations • Final legal agreements • Consents • Who pays legal fees (Capped?) • Exclusivity • No shop • Evidence that all current officers, employees and consultants have entered into the Company’s standard form proprietary information and inventions agreement, and an appropriate employment or consulting agreement, satisfactory to the Lead Investor CONQUERING THE TERM SHEET
- 19. CONQUERING THE TERM SHEET Shareholders agreement Defines: - Pref share permission needed to create new shares, pay dividends, create new class of shares - Change size of board - Indebtedness larger than $X - Granting any security or indebtedness - Changing the nature of the business - Anything out of ordinary course of the business - How much are execs paid?
- 20. TERM SHEET: OTHER TERMS Other terms that you should know: • Dividends • Conversion • Precedent to financing • Vesting • Information and registration rights • Rights of first refusal • Voting rights and employee pool • Restrictions of sales, proprietary inventions • Founders activities • IPO shares purchase • No Shop Agreement • Indemnification and assignment
- 22. NEGOTIATION Entrepreneurs want to: • Build a successful business • Raise enough capital to bring their vision to life • Keep as much control over the company as possible • Share the risk and reward with investors Investor’s point of view • Maximize IRR • Wise spending of money • Not to get diluted • Exit • Reputation
- 23. PICKING WINNERS Due Diligence can take anywhere from 20 minutes (Dragon’s Den) to a few months (Brightspark/OurCrowd)
- 24. PICKING WINNERS Critical Factor Fatal Flaw Product Adoption No evidence potential customers are likely to adopt Route to market No clear channel to market Product development status Much more research and development required Market potential Market size too small Protectability No barrier to entry for competitors Customer engagement Features do not match market need Relevant experience No relevant entrepreneurial/business experience in the team Financial model No clear path to profitability Canadian Innovation Centre – Critical factors for the initial screening stage
- 25. VEHICLES FOR INDIVIDUAL INVESTORS
- 26. BRIGHTSPARK VENTURES PROVEN EXPERTISE & UNPARALLELED NETWORK 20+ years of VC experience, 30+ tech, software & entrepreneur experience Delrina was the grandfather of the tech industry in Canada Many of the best VCs and successful CEOs in Canada “seed” out of Brightspark Repeat entrepreneurs gravitate to us – If there are great deals out there, we see them first! Dealflow is approx. 5-7 deals a year – We seek quality over quantity 80% of our work happens after a deal is closed, growing companies We curate the 1-2% best deals from high-growth potential early stage tech companies Brightspark-managed fund set up per deal and invests in every deal, manages due diligence, co-investments, and overall portfolio Accredited Investors gain insider access to the best deals and invest on a per deal basis alongside top institutions and funds
- 28. OURCROWD Highly selective deal flow: OurCrowd’s team of investment professionals sees 150-200 new opportunities every month, meets 20-30 management teams and, after an in depth due diligence process, selects on average 2-3 to invest in. Access to internal investment rounds: Our team leverages its extensive network to proactively identify and pursue companies we want to invest in, gaining access to investment rounds that are closed to other new investors. Full transparency: OurCrowd invests its own capital alongside our investors in every investment, at the same terms we negotiate with the company.
- 30. BEST PRACTICES Invest in what you know Invest alongside experienced investors Post-investment involvement Investor etiquette Diversify your portfolio
- 31. PORTFOLIO MANAGEMENT TIPS Keep your investment size consistent Double-down on winners in follow-up rounds Diversify – invest across many sectors Build a big portfolio Figure out how much you can afford before deciding how much to invest Be patient Only invest money you can afford to lose
- 32. ASKING THE RIGHT QUESTIONS Questions you should ask: • Yourself • The company you’re considering investing in • Your co-investors
- 33. Q&A
- 34. Q&A
Editor's Notes
- DAVID INTRO We will have a break around 10 Free wifi is “mars open internet”, no username or password We will email you a copy of the slides
- EVERYONE INTRODUCE THEMSELVES
- DAVID - just go over this quickly in case there are any lawyers in the house
- MARK + everyone pitch in NACO report (2015) 1,700 active individual investors 283 investments $133.6 million Since 2010 Nearly 200 exits Totaling $20 billion Approximately 500,000 accredited investors Investment models are evolving
- SOPHIE
- DAVID What is a term sheet? Not legally binding, but the same terms will make their way into legal docs related to the deal When you parse away the legal jargon, they are basically lists of terms that the investor and the startup have agreed to adhere to in this investment Dictates the 2 things that matter most to investors: Money and Control (economics of my investment and the control I have over the company) Who drafts it? What happens to it? Is it changed every round of financing? Let’s look at the most common/important sections of the term sheet. Most important = a) the ones you can usually negotiate or have an impact on. b) The “ones that you HAVE to have”
- MARK Pre-money valuation Post-money valuation Currency Two things that impact valuation: - stock option pools - warrants
- MARK Entrepreneur Math: My company raises $1 million at a $3 million pre-money valuation leading to a $4 million post money valuation. The math works out that the investor owns 25% of the company post deal ($1 million invested / $4 million valuation) and assuming 1 million shares, each share would be valued at $3 / share ($3,000,000 pre-money / 1 million shares = $3 / share). Investors own 25%, I (the founder) own 75%. Investor math – they will assume that valuation includes the Option Pool. Assuming a 15% option pool post funding then you need a 20% option pool pre funding (because the pool also gets diluted by 25% when the VC invests their money). So your 100% of the company is down to 80% even before VC funding. It is standard for new investors to try and get existing investors to be diluted by a full option plan. The VC’s $1 million still buys them 25% of the company — it’s existing shareholders who have diluted to 60% ownership rather than 75%. The price / share is actually $2.40 (not $3.00), which is $3,000,000 pre-money / 1,250,000 shares (because of the new 250,000 share options). Thus the “true” pre-money is only $2.4 million (and not $3 million) because $2.40 per share * 1 million pre-money outstanding shards = $2.4 million. Terms used: This is known as a “fully-diluted cap table” Example: Prior to the closing, the Company shall amend its existing option plan (“ESOP”) in order to ensure that the total number of unallocated shares available for issuance pursuant to options granted under such plan shall represent XX% of the number of Common Shares, calculated on a post-financing, on an as-if-converted and on a fully-diluted basis, as per Appendix I to this Term Sheet.
- DAVID Liquidity event: Selling the company in an attempt to get some money back Definitions: Actual preference: a certain multiple of the original investment per share is returned to the investor before the common stock receives any consideration. (Not very standard nowadays) Participation: full participation, capped participation, non-participation The greater the liquidation preference ahead of management and employees, the lower the potential value of the management / employee equity. There’s a fine balance here and each case is situation specific, but a rational investor will want a combination of “the best price” while insuring “maximum motivation” of management and employees.
- DAVID
- SOPHIE Operating the company: You want to ensure that the company will be well managed, that there are appropriate “checks and balances” in place, that shareholders rights are protected. Board of Directors This is the group responsible managing the company and where major decisions will be made. VCs care about control provisions in order to keep an eye on their investment. It is also a way to ensure their “voice is heard” and that decisions are made with careful consideration and thought. This term spells out how the board of directors will be chosen. - Usually a balance of investor, company, founder and outsider representation. - Chosen by mutual consent of the board (one person = one vote) OR voted upon on the basis on proportional share ownership on a common-as-converted basis. Def: Board (non voting) observer Question: Do you want board representation, control, observer rights?
- MARK Protective provisions are effectively (sometimes veto) rights that investors have on certain actions by the company. They do not eliminate the ability to do certain things, they simply require consent of the investor. Often the topic of hot debates: Entrepreneurs would like to see few or no protective provisions in their documents. Investors– in contrast – would like to have some veto-level control over a subset of actions the company could take, especially when it impacts the investors economic position. Things that are often changed during negotiation: Raising debt threshold Add a minimum threshold of preferred shares outstanding for the protective provisions to apply How does it work for subsequent rounds of financing?
- DAVID Used to protect investors in the event a company issues equity at a lower valuation then in previous financing rounds. Definition: Weighted average anti-dilution Definition: Ratchet based anti-dilution NCP = OCP * ((CSO + CSP) / (CSO + CSAP)) Where: NCP = new conversion price OCP = old conversion price CSO = common stock outstanding CSP = common stock purchasable with consideration received by company (i.e. “what the buyer should have bought if it hadn’t been a ‘down round’ issuance”) CSAP = common stock actually purchased in subsequent issuance (i.e., “what the buyer actually bought”) We advise you not to get hung up in trying to eliminate anti-dilution provisions – rather focus on (a) minimizing their impact and (b) building value in your company after the financing so they don’t ever come into play.
- MARK It causes the investors “stand up” and agree to support the company during its lifecycle at the time of the investment. If they do not, the stock they have is converted from preferred to common and they lose the rights associated with the preferred stock. Recently, this has become much less common than 10 years ago
- SOPHIE The following provisions ensure that shareholders are treated fairly Drag along: Drag-along means that if most investors want to sell, that the minority will be forced to sell as well and get “dragged along” The most common compromise position is to try to get the drag along to pertain to following the majority of the common stock, not the preferred. This way – if you own common – you are only dragged along when a majority of the common consents to the transaction. Tag along (or “co-sales”) Tag-along rights are pre-negotiated rights that a minority shareholder includes in his initial issuance of a company's stock. These rights allow a minority shareholder to sell his share if a majority shareholder is negotiating a sale for his stake. Tag-along rights are prevalent in startup companies and other private firms with considerable upside potential.
- SOPHIE Redemption rights It lets investors require the company to repurchase their shares after a specified period of time. In essence, it’s a “put” right – that is, the investors may elect to put their shares back to the company. Redemption rights are principally designed to protect investors from a situation where, after a period of time, their portfolio company is just moving “sideways” and, accordingly, is not an attractive acquisition target or IPO candidate. Investors are thus given the opportunity to exit their investment by exercising their redemption rights – which is particularly important because venture capital funds have limited lives (typically 10 years). Cofounders, angel investors and venture capital firms alike often rely on tag-along rights. Let's say, for example, that three cofounders launch a new tech company. The business is going well and the cofounders believe that they've proven the concept enough to scale, and seek outside investments in the form of a seed round. A private equity angel investor sees the value of the company and offers to purchase 60% of the company, requiring a large amount of equity to compensate for the risk of investing in the small company. The cofounders accept the investment, making the angel investor the largest shareholder. The investor is tech-focused, and he has significant relationships with some of the larger, public technology companies. The startup cofounders know this and therefore negotiate tag-along rights in their investment agreement. The business grows consistently over the next three years, and the angel investor, happy with his investment return on paper, looks for a buyer of his equity among the major tech companies. The investor finds a buyer who wants to purchase the entire 60% stake for $30 a share. The tag-along rights negotiated by the three cofounders gives them the ability to include their equity shares in the sale. The three cofounders, using their rights, effectively sell their shares for $30 each.
- MARK The “pro-rata right” is the right to continue to participate in future rounds so that you can maintain your ownership. Let’s make it concrete with an example. You invest $50k in a seed round at a $5mm cap and own 1% of the company. The next round is a $3mm round at $9mm pre, $12mm post. If you don’t participate, you will be diluted 25% and will then own 0.75% of the company. On the other hand, if you buy 1% of the round, a $30k investment, you will continue to own 1% of the company. Your “pro-rata right” in this situation is a $30k allocation in the next round. Pro-rata rights are often VERY important to investors. Why? Because you want to “double down on your winners”. So, you want the company to be OBLIGED to let you invest more if you want to in future financings.
- SOPHIE
- SOPHIE
- DAVID – explain that these are either not as important, or usually non-negotiable. Ask if there is a term that anyone would like you to define. If there is extra time, pick a couple to define.
- DAVID After the break: Picking winners/ due diligence Vehicles to invest in startups Best practices Portfolio management tips
- SOPHIE
- MARK First meeting: – understand as much as you can about the business and team Founders/team: who are they? How do they interact? How qualified are they? Business model: value prop, key activities, major assets, distribution channels, problem worth solving? Go to market: Can they articulate their value prop simply? Plan to go to market? Competition? Angle: Secret sauce, how will they revolutionize the market Research: Market size validation (check data provided and find new) Pitch to your network (test their reactions and your assumptions) Reference check – look for mutual friends on linkedin or others Advisors Follow-up meetings – Understand metrics and plan for future Pipeline (churn, customers, industry benchmarks) Product roadmap Financing plan Discuss key issues and challenges More reference checks, customer interviews, digging to uncover every possible piece of information about the company. Then, legal diligence: Skeletons in the closet See how a founder negotiates Legal advisors
- DAVID
- SOPHIE
- MARK Not your typical VC firm. At Brightspark, individual investors can invest with us in exceptional Canadian early-stage tech companies.
- MARK + SOPHIE
- DAVID
- DAVID
- SOPHIE + everyone pitch in Invest in what you know …Or co-invest with people specialized in that industry, who have complimentary skills set Some industries are radically different due to regulatory issues, IP issues, company development paths, exit dynamics… so make sure SOMEONE on the investment side knows what they’re doing. Post-investment involvement How to best help a startup grow Investor etiquette What to do, what not to do
- MARK Diversify: Decide how much you want to allocate to venture capital Consider amount, # of deals, timing Decide how you want to spread your VC investments across companies The Babe Ruth effect: swinging harder produces more strikeouts, but also more home runs (Andreessen Horowitz)
- DAVID
- Moderated by DAVID
- EVERYONE – good opportunity to plug current investment opportunities + sign up process